Treasury Notes: Navigating Mid-Term US Debt Investments

Treasury notes can help diversify portfolios and mitigate the impact of market fluctuations for traders.

However, before making any investment decisions, it's important to understand how they work. Let's discuss everything about treasury notes. 

What are treasury notes?

Treasury notes are a type of debt security issued by the US Federal government. They are similar to bonds but have a shorter maturity period, ranging from two to ten years. Treasury notes offer a fixed interest rate and are backed by the US Federal government. The interest income from treasury notes is also generally exempt from state and local taxes at the federal level.

What affects the value of a treasury note

Interest rates

There is an inverse relationship between interest rates and the value of treasury notes. When interest rates rise, the value of existing treasury notes with fixed interest rates generally falls. This is because investors can purchase newly issued bonds with higher interest rates, making older savings bonds less attractive.

Additionally, the shape of the treasury yield curve (the relationship between interest rates and maturities) can also impact treasury note values. A steep yield curve, where long-term rates are significantly higher than short-term treasury rates, may favor longer-maturity treasury notes.

Inflation expectations

If inflation rises faster than the interest coupon rate on a treasury note, the purchasing power of the future interest and principal payments decreases. This can lead to a decline in the bond's value and vice versa. 

Federal reserve policies

The Federal Reserve's monetary policy decisions, such as interest rate changes and open market operations, can significantly impact the value of treasury notes. For example, if the Fed raises interest rates, it can lead to a decline in the value of existing treasury notes and vice versa. 

Currency fluctuations

Currency fluctuations can affect the value of US treasury notes for foreign investors. If the US Dollar weakens relative to the investor's domestic currency, the value of the treasury note will increase in terms of their local currency and vice versa.

Bond maturity

The time to maturity of a treasury note can influence its sensitivity to interest rate changes. Longer-maturity treasury bonds are generally more sensitive to interest rate fluctuations than shorter maturities’ treasury bonds.

Credit ratings

While the US treasury notes generally have a very low risk of default, changes in the government's credit rating can impact their value. A downgrade in the government's credit rating can lead to increased demand for riskier assets and a decline in the value of treasury notes.

Features of treasury notes

• A treasury note is a debt security with a fixed interest rate and a maturity period ranging from two to ten years

• Treasury notes can be purchased through competitive bidding, where investors specify the interest rate they are willing to accept, or non-competitive bidding, where investors agree to purchase the notes at the auction's prevailing interest rate

• While both treasury notes and bonds are government debt treasury securities, the key difference lies in their maturity periods. Treasury notes have a shorter maturity of two to ten years, while treasury bonds typically have a longer maturity of 20 to 30 years

• Treasury notes are considered liquid, meaning they can be easily bought and sold in the secondary market. This liquidity allows investors to exit their positions if necessary or to take advantage of price fluctuations

Advantages and risks of treasury notes

Advantages

• Low risk: Treasury notes are considered one of the less risky investments available, backed by the full faith and credit of the US government. This means there is a low risk of default

• Federal tax advantages: The fixed income from treasury notes is tax-exempt and provides a Federal tax advantage to investors

• Government backing: The backing of the US government ensures the stability and security of treasury notes, making them a reliable investment option

Risks

• Interest rate risk: If interest rates rise after one purchases a treasury note, the bond's bond market value may decline. This is because investors can purchase newly issued bonds with higher interest rates, making their existing bonds less attractive

• Inflation risk: If inflation rises faster than the interest rate on the treasury note, the purchasing power of the future interest and principal payments decreases. This means the real return on the investment may be lower than expected

• Opportunity cost: Investing in treasury notes involves a trade-off between risk and return. The interest rates on treasury notes are generally lower than other investments with higher risk profiles. This means one may miss out on potential higher returns from other investments

How to invest in a treasury note

1. Understand treasury notes: Investors should familiarize themselves with the features and risks associated with them.

2. Determine investment goals: It is important to define financial objectives, including the desired return, risk tolerance, and time horizon.

3. Choose a purchasing method: The investor needs to decide whether to purchase treasury notes directly through TreasuryDirect or through a brokerage firm.

4. Open an account: If using a brokerage firm, the investor should then open a brokerage account. If purchasing directly, creating a TreasuryDirect account is necessary.

5. Select the type and maturity: Next, the investor chooses the type of treasury note (such as T-bill, T-note, T-bond) and its maturity date based on their investment goals.

6. Place the order: The investor must submit a purchase order through their chosen method, specifying the desired quantity and price.

7. Confirm the purchase: Reviewing the order details and confirming the purchase is crucial.

8. Monitor the investment: The investor tracks the performance of the treasury note, including interest payments and price fluctuations.

9. Redeem at maturity: At maturity, the investor will receive the bond's face value plus any accrued interest.

Diversifying portfolio with treasury notes

Treasury notes offer investors a relatively less risky investment option. They are backed by the government's creditworthiness, reducing the risk of default. Treasury notes can also help diversify the investment portfolio, balancing the risk and return of the investments. 

 

Please note that Blueberry does not issue or make a market in fixed income instruments, including treasury bonds, treasury notes and corporate bonds. This article is for informational purposes only and does not constitute financial advice or a recommendation to invest.